18 July 2008 - On 17 July 2008, the OECD Council approved the release of the 2008 Report on the Attribution of Profits to Permanent Establishments.This followed the earlier approval of the Report by the Committee on Fiscal Affairs at its meeting of 24-25 June 2008.
The Report provides guidance on the principles for attributing profits to a permanent establishment under Article 7 of the OECD Model Tax Convention on Income and Capital . It reflects the results of work undertaken to examine how the principles developed in the OECD’s Transfer Pricing Guidelines for application to separate but associated enterprises should apply in the context of the relationship between a permanent establishment and the rest of the enterprise to which it belongs.
The Report includes a preface and four Parts. Part I sets out general considerations for attributing profits to permanent establishments, regardless of the business sector in which they operate. It describes a two step approach in which the permanent establishment is first hypothesized as a “functionally separate entity” from the rest of the enterprise of which it is a part. In the second step of the approach, the profits of the permanent establishment are determined by applying by analogy the Transfer Pricing Guidelines’ arm’s length principle, including its comparability analysis, to dealings between the permanent establishment and the rest of the enterprise and by pricing in accordance with the Guidelines any transactions with associated enterprises attributed to the permanent establishment.
The latter three Parts of the Report elaborate upon the application of this approach to permanent establishments of enterprises operating in the financial sector, where doing business in permanent establishment form is especially common. Part II describes the application of the approach to enterprises carrying on a banking business through a permanent establishment. Part III addresses the situation of permanent establishments of enterprises carrying on global trading in financial instruments. Finally, Part IV deals with the application of the approach to permanent establishments of enterprises carrying on insurance activities.
This final Report replaces all previous drafts of the various Parts, including the interim version of Parts I III published in December 2006 and the discussion draft of Part IV published in August 2007.
The Committee on Fiscal Affairs has undertaken to adopt a two track approach to implementation of the Report in order to provide tax administrations and taxpayers with maximum certainty as to how profits should be attributed to permanent establishments under both existing and future treaties. In order to provide improved certainty for the interpretation of existing treaties based on the current text of Article 7, a revised Commentary on the current version of Article 7, which includes those conclusions of the Report that do not conflict with the prior Commentary, has been included in the 2008 update to the Model Tax Convention. In order to reflect the full conclusions of the Report, work has also begun on a new version of Article 7, to be included in the next update to the Model Tax Convention and to be used in the negotiation of new treaties and of amendments to existing treaties. A discussion draft of the new Article 7 was released on 7 July 2008.